"While it may be difficult to remain calm during a substantial market decline, it is important to remember that volatility is a normal part of investing." Read more from Dimensional Funds Advisors LP*...
With the recent market volatility that we have experienced since the start of the New Year, there has been some media speculation as to whether this is a repeat of 2008. While there are some significant unknowns in the global economy right now, it is a very different situation from 2008.
In 2008 we had a systemic problem with the U.S. housing market that affected every aspect of the housing sector. To begin with, homeowners took on too much debt. In 2007 households had, on average, debt levels that were 130% of their income. Today that number is 103%. The snowball affect of all that leverage impacted every aspect of the housing market, from homebuilders to mortgage lenders to real estate agents to construction workers, and on and on. In addition, the banks and lenders that held this debt through mortgages had to write off huge amounts of losses.
Today the market concerns are very different. There are two key issues that we are dealing with. The first one relates to the slow-down of economic growth in China. The world has become accustomed to decades of the Chinese economy growing at a very fast clip. Their rate of growth has slowed and the capital markets are trying to figure out what China’s ‘new normal’ will be. Uncertainty typically causes volatility in the markets.
The other key issue is related to the price of oil. There are very few people out there who anticipated oil going below $30/barrel. So while low oil prices offer consumers more disposable income to spend on other goods and services (which is good for the economy), at these prices there are a lot of energy companies that can’t stay afloat and could ultimately need to declare bankruptcy. The investors and lenders to these energy companies would feel the pain.
While these are not insignificant issues, they are not the systemic problems that we were dealing with in 2008. The overall market is near a correction (which is defined as a drop of 10% or more from it’s high point). Market corrections will occur and, while they never feel good, they are part of the investment cycle. We have included the chart that we sent out back in August just as the market turbulence of this summer was beginning. This chart is a good reminder that as long-term investors we are better served to look through the short-term noise that will always exist in the capital markets.
As many of you are probably aware, last week we experienced significant volatility in the global equity markets. While many speculate that it was due to the slowdown of economic growth in China, oil prices back to hitting new lows, and uncertainty over what the Fed will do at their next meeting, the reality is, we have not experienced much volatility in the equity markets in quite some time. Last week's move was the largest down market that we have experienced since 2011. While most investors would like the markets to move at a slow and steady incline, it is not realistic to expect that corrections will not occur from time to time.
None of us know at this point if this is a blip or if there is more downward pressure in front of us. We will only know this in hindsight. To provide some perspective on what has happened in recent history subsequent to major market corrections, please see the chart below.
This chart shows what has happened to the performance of a balanced investment portfolio 1,3, and 5 years after the markets responded to different global crisis over the last 30 years. In all situations a balanced investment portfolio would have experienced solid positive returns after a five year time horizon and all but one event had positive returns after a three year time horizon following a crisis (due to a second crisis occurring within the 3 year time period).
Jenifer Aronson is the Founder of Mosaic Fi.